PACh7 - g increases the numerator increases and the...

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Econ 520 (Spring 2007) Answers to Problems for Chapter 7 Masao Ogaki 2. Multiple-Choice Problems 1-B; 2-D; 3-A; 4-B; 5-A; 6-B 3. Short Answer/Essay Problems (1) When the stock is more risky, the risk premium ( r ) rises. Therefore,the required rate of return ( k e ) in the Gordon growth model rises: P t = D t (1 + g ) k e g : (1) Because the denominator increases, the stock price falls. (Any valuation model with a risk premium can be used for this question.) (2) In the Gordon growth model, when the expected constant growth rate in dividends (
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Unformatted text preview: g ) increases, the numerator increases and the denominator decreases. Therefore, the stock price will rise. (3) Long-term interest rates will fall according to the expectations hypothesis. In the generalized dividend valuation model with di/erent interest rates: P t = D t +1 1 + i t + r + D t +2 (1 + i 2 t + r ) 2 + D t +3 (1 + i 3 t + r ) 3 + : : : (2) the denominator of each term with a long-term interest rate fall. There-fore, the stock price will rise. 1...
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